For those long-time readers of The Weekly Whiteboard, this is not my first piece on inflation, and it certainly won’t be our last, given the client questions and discussions over recent weeks and months. The topic is important to ALL of us, and I wanted to provide some context—at least, context from my perspective!
Beyond Federal Reserve rate movements, Warren Buffett’s activities at Berkshire Hathaway, and Taylor Swift, inflation is one of the most discussed topics in our world, with the potential to significantly influence market behavior. While it’s crucial for investors and investment advisors to consider inflation when planning and allocating assets, it’s equally important not to overreact or allow inflation fears to dictate an entire strategy. Understanding how inflation impacts investments and what strategies can mitigate those effects allows investors to think about inflation without excessive worry.
1. Inflation: A Natural Part of the Economic Cycle
Inflation—the increase in prices over a measured time—is a normal feature of economies. Most governments, through their central banks, aim to maintain inflation at a target level (in the U.S., that target has long been around 2% annually). Moderate inflation is often a sign of a growing economy, indicating increased demand for goods and services. While high inflation can erode purchasing power, low or controlled inflation often leads to increased investment and spending, benefiting both consumers and investors. Investors who understand this dynamic see inflation as a constant but manageable factor. It’s critical to consider how inflation affects various assets while remembering that economies have weathered inflation cycles—both low and high—for centuries.
2. Long-Term Returns Outpace Inflation
Historically, long-term investments, particularly equities, have provided returns that significantly outpace inflation. Over the last century, the stock market has delivered annual returns of around 8-9%, far above average inflation rates during the same period. This outperformance means that while inflation may affect short-term purchasing power, long-term investment gains can help preserve and grow wealth. For investors with a long investment horizon, inflation is less of a risk to worry about and more of a factor to account for when setting return expectations.
3. Diversification Helps Weather Inflationary Periods
Though it may sound trite coming from an investment advisor, diversifying across asset classes can help investors build a portfolio resilient to inflation. Different types of assets respond uniquely to inflationary pressures, and a mix can smooth out the overall impact. Analyzing asset correlations is a fundamental part of our job. For example:
Equities: Stocks in sectors like technology, healthcare, and consumer goods have historically performed well during moderate inflation, as companies can pass rising costs onto consumers. After all, earnings can inflate too.
Real Estate: Property values and rental income often rise with inflation, making real estate an effective inflation hedge (historically speaking).
Commodities and TIPS: Assets like gold, agricultural products, oil, and Treasury Inflation-Protected Securities (TIPS) directly benefit from inflationary periods. While not typically suitable as core investments, they can complement a diversified portfolio.
By holding a mix of asset types and categories, investors can view inflation as an influence rather than a threat, knowing that diversification provides resilience.
4. Inflation Is Often Temporary
I will avoid making the obligatory jab at Fed Chair Jerome Powell for his (infamous) comment about recent inflation only being “transitory”, it’s true that not every inflation surge represents a long-term trend. Many inflationary pressures are short-term, influenced by factors like supply chain issues, policy changes, or geopolitical events. Central banks, particularly the Federal Reserve, monitor and manage inflation by adjusting interest rates and monetary policies.
Investors who react to every inflation scare by overhauling their portfolio or exiting markets often lose out on long-term gains. A better approach is to consider inflation as one of many variables that will fluctuate over time, not a permanent state demanding a total strategy overhaul.
5. Opportunities Can Arise from Inflation
Inflation can create unique investment opportunities. Sectors like energy, consumer staples, and commodities can outperform during inflationary periods. Companies with strong pricing power—those able to raise prices without losing customers—tend to do well. Inflation can also prompt investors to explore value stocks, as growth stocks which are dependent on long-term earnings projections may appear less attractive when inflation and interest rates rise.
Rather than worrying about inflation, investors can use these opportunities to refine their portfolios, finding sectors and companies positioned to potentially thrive under inflationary pressures.
6. A Consistent Investment Strategy Beats Reactionary Resets
History demonstrates that reactionary moves based on inflation fears often lead to poor outcomes. Remaining committed to a long-term investment strategy aligned with personal goals and risk tolerance is generally the best way to build wealth. We periodically review asset allocation to align with both inflation expectations and long-term objectives.
When investors become overly concerned with inflation, they may shift to overly conservative assets, reducing their potential for long-term growth. While a small adjustment might have merit, a larger reset can lead to the very outcome they fear: the erosion of purchasing power over time.
Conclusion: Think About Inflation, But Don’t Let It Control Your Actions
This article focuses on factors investors should consider, not the negative aspects of inflation. By understanding its causes and effects, taking advantage of diversification, and adhering to a disciplined investment approach, investors can position themselves for long-term success.
The best defense against inflation isn’t reacting in distress or hitting the reset button; it’s crafting a thoughtful, resilient strategy that will thrive in varied economic environments. By thinking about inflation instead of worrying about it, investors can make rational decisions that contribute to enduring wealth.
While getting it “right” in the very short term can be challenging, we remain committed to open dialogue and honest communication to help you navigate challenges like inflation and improve your investment and financial planning outcomes.
